Seeds of change

Serious Money:Stephen King's Children of the Corn was first published in 1977 at a time when inflation and social tension were running at unacceptably high levels.

Thirty years later and following two years of outsized gains, the price of corn has returned to the levels that prevailed when King's horror story first appeared in the public domain.

Unfortunately, surging prices are not confined to corn and are evident across the entire food chain. Fears are growing that the world is facing an unprecedented period of food price inflation, a prospect that would lead undoubtedly to nightmares for central bankers everywhere.

Research conducted by William Gavin at the US Federal Reserve shows that a core measure of inflation which includes food but not energy has proved to be a far more reliable indicator of the future trend in consumer prices than the traditional measure that excludes both.

A confluence of factors suggests that food prices could easily double in the next seven years and, consequently, so- called "agflation" looks set to become part of everyday vocabulary.

Growth in global demand for agricultural commodities is on course to accelerate from below 2 per cent a year over the past 10 years to almost 3 per cent a year in the decade ahead.

Population growth, particularly in China and India where the combined population should increase by almost 120 million over the next five years to more than 2.5 billion, alongside increasing per capita income levels will provide a considerable boost to demand.

As income levels rise and the middle class grows, dietary requirements shift from basic cereals and grains to more meat and protein, a trend that is evident in China and India.

Indeed, the annual growth in per capita meat consumption has averaged 4 per cent in China and 2 per cent in India over the past five years.

Unlike cereals and grains, meat is expensive to produce, not only because of the land required for farm animals to graze but also as a result of the large amounts of grain that livestock consumes as it matures to a size suitable for consumption. The typical 1,200lb beef steer, for example, consumes its total body weight in dry feed every month, equivalent to 10 times the amount of grain required to sustain an average adult over the same period. The impact on demand is clear.

The acceleration in demand comes at a time when supply is struggling to keep pace.

In China, for example, increased industrialisation and urbanisation has significantly reduced the land area devoted to agriculture in a country where arable land per capita is already one-third of the world average. China's land shortage is worsened by the overuse and over-cultivation of marginal lands, particularly in the north of the country where roughly 900 square miles of arable land becomes desert each year.

Excessive withdrawal from surface water and from underground aquifers has seriously depleted water resources in China and India.

In China's Qinhai province, more than 2,000 lakes have vanished in the past 20 years, while the water table in the Punjab, India's bread basket, is falling by almost one metre every year.

When agriculture and industry compete for scarce water, it is the farming community that inevitably loses out given that value-added output per ton of water is a mere fraction of the comparable figure for manufacturing. Water scarcity is already showing up in China's grain harvest, which has dropped by more than 25 per cent over the past decade.

The supply constraints in China and India are being aggravated by energy policy in the US, which has seen an increasing proportion of the country's corn crop being sourced for ethanol production.

Indeed, ethanol's share of corn demand is expected to rise to 27 per cent over the next 12 months, up from 14 per cent a year ago. The surge in energy demand has led to a sharp rise in prices and an increase in corn planting, which has led to cutbacks and higher prices elsewhere. Soybean plantings, for example, have dropped to an 11-year low.

Food price inflation is accelerating, with prices increasing at the fastest rate in more than a decade in the US. The cost of food in China rose by nearly 7 per cent in April year-on-year and by more than 10 per cent in India.

Hopes of an early end to the global tightening cycle could well be delayed should current trends persist, as the shock to consumers who have become accustomed to lower food bills could lead to demands for higher wages.

The potential impact in emerging economies is more worrisome given that food costs in countries such as China and India amount to roughly 40 per cent of household income.

The authorities are likely to act forcefully to prevent social unrest. Needless to say, the trend towards higher food prices deserves close scrutiny.